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“The Santa Claus Bubble of 2013” — David Gardner’s Online College “Rule Breaker”

Motley Fool's "College 2.0: Meet the Leader of the Online Education Renaissance."

By Travis Johnson, Stock Gumshoe, July 30, 2013

“This is the only company in the online higher education industry that’s creating a win-win for everyone. Which means it’s the only one with long-term staying power.

The sad truth is, most online colleges exist for one simple purpose. To suck away federal loan dollars from Uncle Sam. These “diploma mills” don’t even care whether their students graduate… as long as they can keep getting new ones….

… most online colleges are bad investments. But that’s exactly why this one is such a GOOD investment!”

That’s the bit that caught my attention in this latest ad from the Motley Fool for their Rule Breakers stock-picking service — the acknowledgement that the sector is terrible, has massive regulatory risk, is rife with fraud and companies you wouldn’t want to have any association with .. and yet, they think there’s one company that’s a good investment in that sector?

Made me wonder which one it is. And while David Gardner has certainly picked some stinkers over the years, he has also had the foresight and persistence to stick with some incredible long-term winners that I didn’t much like (Netflix, Priceline.com) and some that I did enjoy riding along with him, at least for a time (Intuitive Surgical, Marvel). Stock pickers who look for huge, long-term, market-changing growth stories always have lots of bad picks … but the best of them have those few 1,000% winners that more than make up for them.

So, being the Stock Gumshoe, I went lookin’ to see what Gardner’s latest is. Whatever did I find? Keep reading and we’ll share.

The pitch is, basically, that higher education is in a ridiculous tuition hiking spiral that they’re calling a “bubble” — and that’s certainly not something that’s easy to argue about, though even with tuition consistently rising at twice the rate of inflation for decades now, no one is allowed to say that going to college is a bad financial decision (and yes, “twice the rate of inflation” doesn’t sound that crazy — but it compounds incredibly fast, the “list price” cost of attending an elite university has increased by at least 300-400% in just the 21 years since I graduated from college … and people were talking about the unsustainable rate of education inflation back then, too).

If you’re like the average Stock Gumshoe reader, somewhere between 55-75 years old, then there’s a good chance that you could have gone to college at 18 and been able to pretty much cover your costs with a part time job and a good summer job, covering a little extra if necessary with grants and with student loans that no one really thought they had to pay back. That hasn’t been the case for years — college costs make summer jobs seem almost trivial (and hard to get these days), and increasingly the cost is being borne both by parents who are sacrificing their own retirement savings at exactly the wrong time, and students who are taking on crushing levels of student loan debt (debt that can’t be easily written down even if you file for bankruptcy, and which carries a meaningful interest rate).

That doesn’t mean every student is absolutely crushed by student loan debt, of course, but colleges and universities who are selling $100,000 (or $250,000 in some cases) degrees but not really increasing the education level of the students they “teach” in a meaningful way, or giving them marketable skills, connections, or career counseling should certainly be ashamed of themselves. The college years are an important part of “growing up” and becoming an independent adult, but the balance between the cost of this transition period and the gains you make from your college experience means you don’t end up with a clear benefit for everyone.

And I don’t mean just a financial benefit — higher education is not just job training, I do believe that education for its own sake is important, that liberal arts education is valuable and helps to build a smarter and more capable workforce and society even beyond what it does for each individual … but being a B student who doesn’t pay much attention at a diploma mill is not going to do anything except set you up with the credentials to apply for a terrible low-level job in some kind of bureaucratic hellhole. College for college’s sake may have been worthwhile as a transition to adulthood when it was more affordable for a middle-class family, but it’s hard to see it as worthwhile for everyone now unless you get something beyond a four-year hiatus from the adult world. And that’s from someone who comes from an academic family, who has an advanced degree that he’s still paying for (not much, admittedly), and who used to be a university faculty member himself — the system is clearly broken for the average middle class student, even as it is hugely beneficial for some.

But I will briefly remove myself from the soapbox now, because we actually have a teaser to unravel here. The ad talks about Peter Thiel, who’s one of the PayPal founders and has become a legendary venture capital investor … and who also started a controversial program that offered fellows $100,000 to drop out of school and pursue their entrepreneurial dreams (his foundation says it’s working well so far, they’ve had now two “classes” of fellows since starting the program two years ago). Here’s more from the ad …

“Here’s what this legendary Silicon Valley investor is whispering about the $902 billion bubble that’s looming over us right now…
He calls it ‘the only thing people still believe in.’ And says questioning it has become ‘an absolute taboo… like telling the world there’s no Santa Claus.’

“And take it from me. He’s 100% correct! …

“And, just like in 2000 and 2008 — before those last two market bubbles burst and threw our financial world into chaos — an elite group of savvy investors are quietly making their big move.

“See, they’re not selling in anticipation of this bubble. They know that’s a sucker’s game.

“They’re BUYING.

“But they’re being extremely selective….

“… to call this stock “bubble-proof” might actually be a drastic understatement

“Because if Peter Thiel and David Gardner are correct …

“Then the explosion of this $902 billion debt bubble will coincide with the extinction of many of these 3,350 overpriced dinosaurs.

“And, more importantly for you and your historic wealth-building opportunity today, it will blast this superstar tech stock right into the stratosphere.”

The Fool employee who wrote this particular ad letter is a former academic, too — here’s what he says about the “big picture” that sets the stage for the investing idea he’s sharing:

“One day I realized something while I was talking with the students in my Beatnik poetry course. (It’s OK, I laughed a little too as I was typing that just now!)

  • “On the one hand, university tuitions were skyrocketing out of control. Even at “affordable” state colleges like the University of Florida. In fact, the average price tag for a bachelor’s degree has climbed to more than $100,000.
  • “On the other hand, 70% of the courses at these increasingly expensive universities were being taught by poorly paid “non-tenure track faculty.” By adjunct professors on temporary contracts. Or even by partially-trained graduate students like me.
  • “In other words, my students were paying MORE to go to college, but getting LESS for their money!

“… to tell you the truth, I felt kind of like the entry-level salesman in a pyramid scheme.”

So which of the education stocks are they talking about here as the way to shake up the industry and profit from the current crisis? Let’s see what they give for the details … or as I call ’em, “clues”:

“Like a lot of revolutions, this one started with a few venture capitalists in Silicon Valley.

“And it soon caught the attention of the Pentagon and the National Football League….

“I found this latest breakthrough in online education quite surprising.

“But when it comes to technology, tipping points can happen fast. Remember when online dating was considered “weird”?

“Nowadays, I know quite a few people who met their husband or wife online. And quite a few more who are hoping to.

“And as an investor, I also know that the higher education industry is 547 times bigger than the online dating industry! …

“A lot of university administrators are still in denial that online delivery creates a real alternative to their old way of doing business… just like the fatcats who once ran big record labels and big bookstores were.”

OK, so that just confirms that we’re probably looking at on online college — which, as we noted, has been a terrible industry. But is it one of the usual suspects, or something different?

Some more clues:

“… converted to an all-online course format way back in 1998 ….

“… out of all 127 of David [Gardner]’s active rule-breaker stocks, only Google has a safer risk rating …

“… this stock jumped up 18% in May …”

“… already serves 115,000 students. And 97% of the students say they would recommend it to their friends and co-workers…

“… this company’s top brass includes 4 Ph.D.’s, a healthcare CEO, a GE vice president, an Air Force nuclear weapons expert, an IBM-trained software engineer, and a top consultant for Deloitte. And here’s what’s smarter still… their executive bonuses are set up to reward decisions that are good for both students and shareholders. So 14 cents of every dollar this company’s CEO made last year was tied directly to those student satisfaction ratings….”

So that sounds pretty interesting, no? It’s also probably expensive — as usual for a Rule Breakers pick, David Gardner says that in order for a stock to meet his criteria it has to, “at some point, be so successful that the financial media believe it to be overvalued.” They also note, as evidence of this, that Jim Cramer said it wasn’t worth buying back on March 1 of last year.

They say that this company has been able to avoid being a “churner” — getting so dependent on more and more students coming in the door that they start to downplay student achievement and invest more and more in marketing to increase the number of students, with one example being the University of Phoenix and their deal to buy the naming rights to an NFL stadium. (University of Phoenix, with almost 300,000 students, is the major asset owned by the Apollo Group, ticker APOL, which like most for-profit education stocks is, in my opinion, lousy and cheap).

Some more from the ad:

“… this college can invest in getting world-class professors. Like Dr. Alan Hale, who discovered the Hale-Bopp comet in 1995.

“As a recent report in Forbes revealed, “in an apples to apples comparison, in a given course,” this company is less expensive than ALL of its lower-quality online competitors, AND also 10-15% less expensive than a traditional state college like the one I used to teach at.

“That’s why the Pentagon relies on this online college to educate America’s soldiers, sailors, and airmen… in fact, this Rule Breaker educates more service members than any other college.

“It’s also why the NFL player’s association signed an exclusive contract with this company to offer courses to its football stars. Like Pittsburgh Steelers Pro Bowl linebacker Levon Kirkland, who’s studying for his master’s degree in management.”

OK, so that’s enough clues for us to name the company for you — and enough to get an idea of why the Motley Fool likes them. But do they say anything about the financials, or why it’s a good investment?

Well, the basic spiel for buying now seems to be that David Gardner thinks the stock is not nearly as endangered by the federal budget sequester (remember, lots of military students) as other analysts believe … he apparently thinks that we need to buy before next week:

“Before this ‘top dog’ online college releases its latest student enrollment statistics on August 5. Because in our judgment, that’s what will provide the slam-dunk evidence that they’re not only sequester-proof, but also completely bubbleproof and bulletproof.”

OK, so that’s about all they tell us. What’s the stock? This is … American Public Education (APEI), owner of American Public University and American Military University.

And I expect they’re building in a wee bit of leeway with the August 5 date — they will be releasing their next quarterly results on August8 before the market opens, so for our purposes that means buying before this announcement would mean you have until August 7. Unless they report their quarterly enrollment numbers publicly somewhere else first, which seems unlikely given the SEC’s rules.

While David Gardner thinks they should be doing better than other analysts expect, the company has guided down a bit in lowering expectations for new student enrollment — they do say that they’ll grow course enrollments and earnings, but that the number of new students added will fall for the second quarter. Here’s the guidance they gave back in May:

“The Company believes that the temporary suspension of Department of Defense (DoD) voluntary education Tuition Assistance (TA) programs negatively impacted net course registrations in the months of April and May 2013.

“As a result of the temporary suspension of TA, sequestration-related events and other possible factors, American Public Education anticipates second quarter 2013 net course registrations by new students to decline between -14% and -10% year-over-year; net course registrations to increase between approximately 9% and 12% year-over-year; and revenues to increase between approximately 10% and 13% over the prior year period.

“In the second quarter of 2013, the Company expects net income to be between $0.53 and $0.58 per diluted share, which includes approximately $0.02 to $0.03 per diluted share of legal and financial due diligence expenses incurred in connection with the Company’s review of potential transactions.”

If there continues to be pressure on the tuition assistance programs offered by the military, that would obviously hurt over the long term — if you don’t bring in new students, then eventually the students you have graduate or drop out and you stop growing. I don’t know what the big picture risks of that are, though they are not just a university for defense employees … it’s interesting to note that last paragraph, the cost of their due diligence as they review “potential transactions.” Seems like they may be looking for growth by adding other universities to their stable, which could lead to some opportunistic opportunities if they can do so without screwing up — there are plenty of for-profit education companies that look quite cheap and could be accretive to earnings for APEI.

This isn’t the first time the Foolies have teased the idea of buying a for-profit education stock — last time I covered such a pitch is was when the Fool’s “Special Ops” service was teasing Bridgepoint Education (BPI), and at the time (almost two years ago) I said that the proliferation of scams and scandals in the industry led me to preferring either the super-cheap stocks like BPI, or the “gold standard” APEI. I didn’t buy either, and haven’t missed much — over the last two years APEI has come out about even and BPI is down substantially, both of them doing much worse than the broader market. So is this an opportunity again? Is APEI “bulletproof” and safe and primed to grow, as David Gardner appears to believe?

Well, I have no experience with them as either teacher or student, but they do have a better reputation than many of the for-profit firms — though of course, they also compete with a huge number of colleges and universities that also have a physical presence, the vast majority of which are non-profits. APEI seems to have done very well in its niche, particularly with government and defense employees, and they have structured the company in the right way to focus on student achievement, but I can’t tell you much more than that. They are in the top 25 of the US News ranking of top online bachelor’s degree programs, but just barely, and they do focus on non-traditional students (their average age for an incoming bachelor’s degree candidate is 31, and only a tiny percentage, fewer than 5%, are taking college courses for the first time). But it’s also true that you don’t see them criticized and vilified the same way Apollo Group, Bridgepoint and Corinthian Colleges, among others, have been over the years. They also face the same competitive threat as traditional colleges in the form of online MOOCs (massively online open courses) and other more revolutionary ways of dispensing the online equivalent of lecture courses and textbooks, but I expect that particular threat is probably overstated for at least the foreseeable future — people won’t stop getting serious, accredited degrees just because there are some lecture classes they can “attend” for free.

Looking just at the financials, it’s an excellent business — as befits a college with no campus to mow and no football team to feed, they sport rich operating margins of better than 22% even with a pretty good faculty/student ratio … and no, they’re not hiring faculty members to do scientific research, they’re hiring them to teach, so students might expect to get more “real” faculty time than they would at a large traditional university. The PE ratio has been in steady decline as the bloom has come off the for-profit-education rose in the eyes of investors over the last five years, so the upshot is that although they’re still more expensive than downtrodden competitors like Bridgepoint or Apollo, they’re actually given a pretty average valuation compared to other sectors — forward PE around 13, trailing PE around 15, growing earnings at 25% in the last quarter and expected to grow at better than 15% annually … that’s very reasonable.

Analysts are clearly concerned about the sector, whether it’s because of the military budget sequester or because of online scrutiny of student loan costs, so even with that lofty expectation for earnings growth they’ve got an average price target of about $42 on the stock, just a few dollars from where it stands right now, and the analysts are pretty evenly divided between “hold”, “buy” and “strong buy.” They are rated better than any of the other online education stocks I checked, many of which are expected to see falling earnings (APOL, COCO, DV, ESI), but there’s clearly still some worry among investors or the stock would be higher based on their earnings and their growth prospects.

There isn’t any meaningful insider ownership, nor has there been any insider buying, which is not so much a negative as it is the absence of a positive. The balance sheet is excellent, with a few dollars a share in net cash and no debt, so they do have some flexibility to grow through acquisition if they choose that path (as seems likely). What does that mean?

Well, if I were going to buy an online college I’d still be most comfortable with this one. And I still don’t own it, and haven’t felt compelled to rush into buying it the few times that I’ve taken a brief look over the years. I expect I’ll keep looking. If you’ve got an opinion on APEI or the for-profit education sector, feel free to share it with a comment below. And, of course, if you’ve ever tried Gardner’s Rule Breakers service, please click here to review it for your fellow investors. Thanks!

Disclosure: I do own shares of Google, which was mentioned briefly above. I do not own any of the other stocks mentioned, and won’t trade in any stock covered for at least three days.

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8 years ago



8 years ago
Reply to  jcalvert

I am an Irregular, the ads are there, they are automatic, they do not seem overbearing to me compared to many other sites. They are not necessarily recommended as they are automatic and most likely a supplementary source of income for the site. The best reasons to pay to be an Irregular in my opinion are a) Support Travis and his work, b) Get access to Irregular content and b) The reviews of teasers get a small summary that is helpful if you don’t have time to know if you have time to read it or not, you can find out in a few seconds by reading the summary.

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8 years ago
Reply to  rkatz0

Are the irregulars invited to an annual meeting at Stately Gumshoe Manor?

8 years ago
Reply to  John

I believe there’s a ritzy garden party, and you can bid mucho dollars for the chance to have dinner in the presence of the Gumshoe himself. Extra to have your photo taken. Bow tie optional. Location not known – but Omaha springs to mind.

Slick Rick
Slick Rick
8 years ago
Reply to  Penny

I am sure that the “Irregulars” NEVER get to see the young …….ahem ladies that come out after the Garden Party! That is the way life is , Money Talks and B.S. walks!

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8 years ago
Reply to  rkatz0

Amen Randy!
perhaps u’d rather pay double or triple the extremely low membership price.

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